July 26, 2019

An Introduction to Litigation Finance

David Shack

A Common Problem

We live in a world where access to justice often depends on access to capital. Many claimants face insurmountable challenges due to a lack of economic resources and, regardless of the merits of their claims, find themselves unable to receive the justice they deserve. The ever-rising cost of litigation often provides well-capitalized defendants with an overpowering weapon: financial asymmetry.

Many defendants often engage in costly wars of attrition, the primary intent of which is to exhaust and overwhelm plaintiffs with limited resources. What may result is the deferral or total abandonment of legitimate claims of plaintiffs unable to maintain financial stability throughout the course of litigation. Under these circumstances, outspent individuals or companies need a strategic way to rebalance the scale in their challenge to remain on level footing with well-capitalized defendants.

A Modern Solution

Accordingly, plaintiffs need a partner to help monetize the outcome of their claims, in order to afford all the associated costs. Litigation finance enables just that––it helps to make justice accessible to claimants who otherwise might lack the resources to attain it.

Third-party litigation finance (also called litigation funding) is designed to provide a more efficient and equitable means of redistributing risk and equalizing the bargaining power of litigants by providing capital to plaintiffs using novel financial products.

What Is Litigation Finance?

Litigation finance is the process where a third-party unrelated to the lawsuit provides capital to a plaintiff involved in litigation in exchange for a portion of the monetary recovery in the event of a successful settlement or judgment. This outside capital is made available to pay for the costs of litigation, including attorney fees, expert witness fees, and court costs. It can also fund ongoing working capital requirements of corporate plaintiffs and law firms. In most cases, such investments in litigation are non-recourse.

Origins

Modern litigation finance is less than three decades old, having originated in Australia and the United Kingdom. The practice expanded to the United States in the mid-2000s and has experienced rapid growth since. A growing demand for litigation finance products has seen a massive inflow of capital for the direct purpose of financing legal claims. The current estimate of market demand is in excess of $50 billion. There are now dozens of litigation finance firms using a variety of investment criteria, from large single commercial claims, to portfolios of lawsuits, to law firm loans, to smaller personal injury matters.

A Brief Look at Regulation

Despite significant growth of the industry over the past decade, there is no comprehensive federal regulatory regime for commercial litigation finance. What exists instead is a patchwork of case precedent, ethics opinions, and common law doctrines––all of which influence the availability of litigation finance on a state-by-state level. While certain states, including Alabama, Colorado, Minnesota, and Kentucky, have declared certain third-party funding agreements invalid, a majority of states allow litigation finance to be made available to party plaintiffs.

The Benefits of Litigation Finance

Litigation finance levels the playing field for undercapitalized litigants by offering a number of critical benefits to plaintiffs and their attorneys. Most critically, this funding enables plaintiffs to pay for expenses at any stage of the litigation process, providing access to premium resources such as experienced lawyers, highly regarded expert witnesses, and other support services. By being able to adequately resource their claims, plaintiffs can thereby gain the benefit of better litigation outcomes more closely aligned with the merits of their claims. Similarly, law firms can leverage litigation funding to unlock liquidity for working capital, thereby minimizing concerns over delayed payments and staggered cash flow.

Litigation funding can also be made available to serve the needs of corporate legal departments, where controlling risk and legal costs are primary objectives. Traditionally viewed as cost centers, litigation finance can transform the legal department into a profit center by enabling the monetization of illiquid but meritorious legal assets, while also providing a measure of certainty to the balance sheet, a resource not previously available.

The direct benefits of litigation finance in the context of environmental matters are clear. Using a hypothetical example, perhaps a large manufacturer is discovered to be responsible for a toxic chemical leak that contaminated residential water sources. The leak is ultimately linked to multiple reports of serious illness. Under these unfortunate circumstances, the representative law firm might engage with a third-party funder to assist with the financing of a class assembly via marketing programs, or to finance firm operations during any prolonged litigation if taken on full or partial contingency.

Addressing Criticisms of Litigation Finance

Perhaps the most common criticism leveled at litigation finance relates to legal ethics: the suggestion that the process has the potential to negatively impact the attorney-client privilege if funders demand control over litigation strategy in order to protect their investments. However, a close examination of how litigation finance firms originate and structure their investments reveals these concerns to be overstated. While the “common interest” doctrine that preserves privilege is not universally recognized, more and more courts have begun recognizing the importance of allowing litigants to share privileged information and work product with third parties who may share their lawsuit-related interests. This approach focuses on whether the client and third party to whom the privileged information is disclosed are engaged in a “common enterprise,” and whether the information shared relates to the enterprise’s goal. The alternative “legal interest” approach requires that the interest shared by the client and third party be strictly legal in nature. Further, most funding companies remain passive investors, as their investment agreements expressly disclaim any right of control over litigation strategy or settlement negotiations.

Another common criticism of the litigation finance industry is that the growing availability of legal capital will inevitably lead to a surge of frivolous lawsuits. Experience has shown this not to be the case, and with good reason. Litigation funders make investments in legal claims to generate returns––thorough diligence ensures that investments are made only in highly meritorious matters having high likelihoods of positive outcomes. That being said, if greater access to justice is the desired outcome, an increase in access of meritorious claims should be welcomed as more plaintiffs become able to assert their rights in our legal system.

The Future of Litigation Finance

As the litigation finance industry expands, new products will emerge to address an even broader range of needs. We have already witnessed significant geographic expansion, with providers offering services in jurisdictions like Hong Kong, Singapore, and mainland China. We can also expect to see wider implementation of defense-side funding products, where capital commitments are made in exchange for a portion of the damages saved, thereby empowering defendants to mitigate litigation costs and minimize downside risk. Looking forward, the growth and globalization of investments in legal claims is likely to spur greater transparency and standardization, coupled with the prospect of consolidation among industry participants.

The litigation funding space, while still nascent, has achieved considerable momentum in recent years. As the industry matures, and new business models are tested across different markets, we expect the practice to become a permanent fixture of the modern global legal system. As such, it is clear how this increasingly valuable and widely accepted tool is well-positioned to continue its role in making justice attainable for all those who deserve it.

David Shack

David Shack is LexShares' vice president of Marketing & Product Strategy, responsible for the firm's brand and growth activities, as well as the design and management of its product and technology initiatives. To learn more about the burgeoning practice of litigation finance, read the Litigation Finance 101 Guide, written by LexShares, a leading commercial litigation finance firm.